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Federal Reserve Releases Paper Studying the Evolution and Forward Looking Growth of Fintech
On August 1, the Federal Reserve Board released a paper on the origins and growth of financial technology, and how these “deep innovations” have the potential to affect financial stability. The paper, “FinTech and Financial Innovation: Drivers and Depth,” was authored by John Schindler and adapted from a speech prepared for Banco Central do Brasil’s XI Annual Seminar on Risk, Financial Stability and Banking. Fintech, according to Schindler’s adaptation of the Financial Stability Board’s definition, is best understood as a “technologically enabled financial innovation that could result in new business models, applications, processes, products, or services with an associated material effect on financial markets and institutions and the provision of financial services.” Schindler considers the following to fall into the definition of fintech: (i) online marketplace lending; (ii) equity crowdfunding; (iii) robo-advice; (iv) financial applications of distributed ledger technology; (v) and financial applications of machine learning (also called artificial intelligence and machine intelligence). The paper provides a deeper discussion into the following topics driving fintech innovation:
- supply and demand factors of financial innovation, including regulatory changes and changes to financial or macroeconomic conditions, contributing to the use of technologies supporting fintech financial products and services;
- depth of innovations such as peer to peer lending, high frequency trading, mobile banking and payments, bitcoin, and blockchain all with the “potential to have transformational effects on the financial system”; and
- demographic demands.
Schindler’s position is that fintech evolved, in large part, due to a combination of a number of supply and demand factors occurring in a relatively small period of time, which, as a result, drove new financial innovations.
SEC Issues Investigative Report: Federal Securities Laws Apply to Virtual Organizations
On July 25, the SEC issued an investigative report stating that federal securities laws apply to anyone who offers and sells securities in the U.S., regardless of the manner of distribution or whether dollars or virtual currencies are used to purchase the securities. The SEC’s Report of Investigation (Report) advises users to make sure they are compliant with federal securities laws when raising capital through Decentralized Autonomous Organizations (DAO) or other forms of distributed ledgers or blockchain technology. These offering are often referred to as “Initial Coin Offerings” (ICOs) or “Token Sales.”
The Report originates from an Enforcement Division inquiry into whether the DAO—and affiliated entities—“violated federal securities laws with unregistered offers and sales of DAO Tokens in exchange for ‘Ether,’ a virtual currency.” According to the SEC, the DAO, which has been described as a “crowdfunding contract,” has not met any of the specific Regulation Crowdfunding exemption requirements issued earlier this year by the agency. These regulations were previously discussed in InfoBytes. In its Report, the SEC stated that the individuals involved in a 2016 virtual currency offering that was later hacked will not face charges, but will rather serve as a warning to the industry that people who offer and sell securities in the U.S. must follow the law. In light of this discussion, the SEC’s Office of Investor Education and Advocacy issued an Investor Bulletin to educate investors about the benefits and risks of ICOs, which promoters have begun to use to sell virtual currencies.
“Investors need the essential facts behind any investment opportunity so they can make fully informed decisions, and today's Report confirms that sponsors of offerings conducted through the use of distributed ledger or blockchain technology must comply with the securities laws,” said William Hinman, SEC Director of the Division of Corporation Finance.
BAFT Announces 2017 Global Payments Symposium; Will Highlight Advances in Payments Innovation, Blockchain, and Artificial Intelligence
On July 19 and 20, the Bankers Association for Finance and Trade (BAFT) will host its 2017 Global Payments Symposium in New York City. The symposium will help bankers and payments professionals understand the latest innovation trends affecting compliance, payments, blockchain, fintech, cybercrime, and artificial intelligence, among others. BAFT will also discuss methods to integrate innovations into the business lines and how global challenges and best practices impact the U.S.
House Subcommittee on Digital Commerce and Consumer Protection Holds Hearing to Discuss Consumer Fintech Needs
On June 8, the House Energy and Commerce Committee’s Subcommittee on Digital Commerce and Consumer Protection held a hearing to discuss financial products and services offered by the fintech industry to meet consumer needs. (See previous InfoBytes coverage here.) Committee Chairman Rep. Bob Latta (R-Ohio) opened the hearing asserting, “There are serious opportunities for companies to reach consumers with new products to help them create a rainy-day fund for the first time, pay their mortgage securely, rebuild their credit, budget and manage multiple income streams, and invest their earnings . . . Cybersecurity [specifically] is an ongoing challenge, and one the Energy and Commerce Committee is tackling head on.” The June 8 hearing included testimony and recommendations from the following witnesses:
- Ms. Jeanne Hogarth, Vice President at Center for Financial Services Innovation (CFSI) (statement). Hogarth stated that nearly three out of five American face financial health struggles and spoke about challenges fintech entrepreneurs may face when trying to help consumers, such as (i) “facilitat[ing] interstate and regulatory comity that enables consumers to access and use fintech products and service that promote financial health”; (ii) “support[ing] consumers’ access to their own data”; and (iii) “creat[ing] opportunities for pilot testing of both financial products and services and financial services regulations.” Hogath also detailed CFSI’s Financial Solutions Lab, which identifies financial health challenges faced by consumers and encourages companies to develop ways to address these issues.
- Mr. Javier Saade, Managing Director at Fenway Summer Ventures (statement). Saade—whose venture capital firm backs emerging fintech companies—stressed the importance of understanding and mitigating associated risks as financial innovation continues to expand. Growth is supported and encouraged, he noted, provided entrepreneurs understand that the “’fail fast and often’ approach, typical of tech-driven startups in other sectors, may not be well suited for the financial services industry.” Furthermore, Saade stated that because “nearly 30 million U.S. households either have no access to financial products or obtain products outside of the banking system . . . even modest strides in achieving economic inclusion present the single largest addressable opportunity in fintech.”
- Ms. Christina Tetreault, Staff Attorney at Consumer Union (statement). Tetreault, speaking on behalf of Consumer Union (the policy division of Consumer Reports), stated that while financial technology such as virtual currencies, digital cash, and distributed ledgers have the “potential to increase consumer access to safe financial products and return a measure of control to consumers,” safeguards devised between lawmakers and providers must be implemented with appropriate federal and state financial regulator oversight.
- Mr. Peter Van Valkenburgh, Research Director at Coin Center (statement). Coin Center is a non-profit organization, which focuses on “public policy ramifications of digital currencies and open blockchain networks.” Van Valkenburgh emphasized the need for Congress to (i) create a nationwide federal money transmission license as an alternative to “state by state licensing,” which, in his opinion, emphasizes the needs of individual states rather than addressing the health and risk profile as a whole; and (ii) create a federal safe harbor to “protect Americans developing open blockchain infrastructure.” Van Valkenburgh also encouraged the Office of the Comptroller of the Currency to establish federal “fintech charters” to promote a unified approach to regulating blockchain companies.
FINRA Announces Fintech Outreach Initiative, Hosts Blockchain Symposium in July
On June 13, the Financial Industry Regulatory Authority (FINRA) announced a new outreach initiative to improve its understanding of fintech innovations and how they impact the securities industry. The Innovation Outreach Initiative will consist of the following components:
- the launch of FINRA’s new webpage dedicated to fintech topics such as RegTech (covering compliance monitoring, fraud prevention, data management, and the identification and interpretation of regulations affecting the securities industry), artificial intelligence, and social media sentiment investing; and
- the creation of a cross-departmental team led by the Office of Emerging Regulatory Issues developed to, among other things, foster discussion on fintech developments, develop publications on fintech topics, and increase collaboration with domestic and international regulators.
Additionally, FINRA announced it will host a Blockchain Symposium in New York City on July 13 to create an opportunity for regulators and industry leaders to join together and discuss opportunities and challenges related to the use of Distributed Ledger Technology, also known as blockchain.
Vermont Governor Enacts Law Including Blockchain Application
On June 8, Vermont Governor Phil Scott signed into law legislation (S. 135), which would, among other things, allow for broader business and legal application of blockchain technology to promote economic development. Additionally, S. 135 requires the Center for Legal Innovation at Vermont Law School, the Commissioner of Financial Regulation, the Secretary of Commerce and Community Development, and the Vermont Attorney General to prepare a joint report for the General Assembly on “findings and recommendations,” as well as policy proposals and “measurable goals and outcomes” concerning “potential opportunities and risks presented by developments in financial technology.” The new law follows the passage of House Bill 868 last June, which defined blockchain as “a mathematically secured, chronological, and decentralized consensus ledger or database,” and formally recognized blockchain-notarized documents as having legal bearing in a court of law.
As previously reported in InfoBytes, Arizona recently enacted a similar law (AZ H.B. 2417) recognizing blockchain signatures and smart contracts under state law.
First State Moratorium on Blockchain Taxes in Nevada
On June 5, the governor of Nevada signed into law legislation (SB 398) that prohibits local governments from taxing or establishing restrictions on blockchain use—making it the first state to outlaw blockchain taxes. In addition to taxes, the new law prohibits requiring a license, permit, or certificate or any other condition on the use of blockchain. The bill also states that blockchain data can now be submitted in situations where the law requires a record to be in writing.
West Virginia Enacts Law Defining "Cryptocurrency" in Context of Money Laundering
On April 26, West Virginia Governor Jim Justice approved new legislation (H.B 2585) that defines cryptocurrency in the context of money laundering. Specifically, “cryptocurrency” is defined as “digital currency in which encryption techniques are used to regulate the generation of units of currency and verify the transfer of funds, and which operate independently of a central bank.” Furthermore, the term “monetary instruments”—traditionally defined, for example, as coin, currency, checks, gift and prepaid credit cards—would now include cryptocurrency. With respect to the anti-money laundering clause, the legislation makes it unlawful to “conduct or attempt to conduct a financial transaction,” which would include cryptocurrency transactions, “involving the proceeds of criminal activity knowing that the property involved in the financial transaction represents the proceeds of, or is derived directly or indirectly from the proceeds of, criminal activity.” H.B. 2585 also outlines penalty structures for violations of the legislation—misdemeanor or felony charges depending on the severity of the crime—and allows for forfeiture or disgorgement of cryptocurrency.
GAO Publishes Study Examining Fintech Industry Regulation
On April 19, the U.S. Government Accountability Office (GAO) published a study examining four “subsectors” within the fintech industry—marketplace lenders, mobile payments, digital wealth management platforms, and distributed ledger technology (also known as blockchain)—and highlighting the types of products and services offered and how they are regulated. The report, Financial Technology – Information on Subsectors and Regulatory Oversight, is the first in a series of planned reports on fintech, following a request by Congress for a review of issues related to the industry. From July 2016 to April 2017, GAO reviewed agency publications, guidance, final rulemakings, initiatives, and enforcement actions, and also conducted interviews with representatives from the federal prudential regulators, state supervision agencies, and trade associations in order to compile the findings in the report. The report provides an overview of the technologies associated with each subsector, identifies primary users of the products and services, notes potential benefits and risks, and highlights industry trends and current regulations and oversight. Notably, GAO stated it made no recommendations in this report.
Arizona Enacts Laws Providing for Legal Recognition of Certain Electronic Signatures and Other Records
Last month, Arizona Governor Doug Ducey signed into law two pieces of legislation (S.B. 1084 and S.B. 1078), which formally grant legal recognition of electronic records and signatures under state law. Specifically, the new laws—each of which were passed unanimously by both houses of the Arizona legislature—formally acknowledge the legality of certain electronic records and signatures for the purpose of “satisfy[ing] any law that requires a record to be in writing or to be retained or both.” S.B. 1084 further details the requirements that must be satisfied when creating, sending, and accepting electronic signatures or records in order to qualify for legal recognition under the new law. As previously reported in InfoBytes, Arizona also recently enacted H.B. 2417, which recognized blockchain signatures and smart contracts under state law.